GOLD BUYING is boosted more by rising GDP and stronger consumer incomes than by financial crisis, according to a new study from a world-renowned economics professor.

Defying the developed West’s common belief that gold is only for bad times, the report confirms what market-development organization the World Gold Council calls “gold’s positive duality: its ability to benefit from both the contraction and expansion phases of the business cycle.”

The econometric study comes from Avinash Persaud – emeritus professor at Gresham College, visiting fellow at CERF-Cambridge University, and governor of the London School of Economics – who was commissioned by the World Gold Council to study consumer versus investment gold buying both globally and in 11 key countries.

Over the last five years, world demand to buy gold jewelry has accounted for 48% of annual purchases, and a further 10% has gone to electronic products such as PCs and smartphones. With central banks buying 7% on average, and despite the global financial crisis, gold investing has accounted for less than consumer demand – some 35% per year since 2009.

“The new analysis,” says the Council, presenting Professor Persaud’s findings, “shows that a 1% increase in GDP lifted jewellery consumption by an average of 5%, all else equal.” Because “gold jewellery is what economists refer to as a ‘superior’ good,” says Persaud, “where demand increases proportionally more than income.”

The same 5:1 relationship applies to electronics demand compared to GDP growth, too.

Although gold investment demand is “much smaller” than jewelry buying, however, “shifts in investment demand can be large and play a critical swing role in the market,” Persaud cautions.

“However, the longer-term trend is more closely linked to global consumption, savings and, at the same time, by the availability of supply.”

India and China lead world demand to buy gold, accounting for one ounce in every two sold worldwide last year. Asian households’ propensity to buy gold is far greater than Western consumers’, the report says, because they “typically devote more money to savings” with a real average saving rate around 30% of income.

Even so, half of US gold buying “is [also] linked to consumers”. US jewelry fabrication will rise 6% this year from 2013, according to leading consultants Thomson Reuters GFMS in the latest Update to their Gold Survey 2014.

On the supply side, says GFMS, US scrap sales – which soared as prices rose during the financial crisis, enabled by companies like Cash4Gold – fell 17% in the first half of 2014 from a year ago.

Such recycling flows from consumer worldwide fell 9% “as the need to raise funds by cashing in gold assets dwindled,” the consultancy says, “due in large part to an improved US economy.”

“Given a strong price elasticity of demand in many countries,” says Professor Persaud – pointing to Asia’s huge move to buy gold on 2013’s thirty per cent price drop – “a trebling in the gold price [from 2009-2014] should have led to an even greater decline in gold jewellery consumption, and if prices were to stay high, a permanent decline in consumption.

With a degree in corporate and investment finance, plus extensive experience in merger and acquisitions and small-company financing and promotion, Coffin has for many years tracked the financial performance and funding of all exchange-listed Canadian mining companies, and has helped with the formation of several successful exploration ventures.

One of the first analysts to point out the disastrous effects of gold hedging and gold loan-capital financing in 1997, he also predicted the start of the current secular bull market in commodities based on the movement of the US Dollar in 2001 and the acceleration of growth in Asia and India.

Now Coffin tells The Gold Report how the continuing strength of the US Dollar is bad news for the price of gold, and believes that in the short term a price of $1200 per ounce is possible, though there is room now for an oversold bounce…

The Gold Report: You told us last year you were “neutral” on the state of the US economy. Since then, the headline unemployment number has improved. Even so, as David Stockman, former director of the Office of Management and Budget, says, there have been no net new jobs created since July 2000, and jobs paying over $50,000 per year have disappeared by 18,000 per month since 2000. What is your view of the health of the US economy?

Eric Coffin: I’m more positive than neutral these days, but I do agree somewhat with Stockman. As unemployment falls toward 6%, we would expect an increase in wage gains. But we’re just not seeing that. And five years into the latest expansion, we’re not seeing the economic growth spurts that tend to occur coming out of a really bad recession. I don’t see how the US economy keeps reproducing the 4% growth of Q2 2014 if we don’t see higher wage gains and higher paying jobs created.

TGR: You’ve used the term “smack down” with regard to the recent falls in the gold price. What do you mean by this?

Eric Coffin: It’s a wrestling term and means being thrown to the mat. This is what has happened to gold time after time, after every uptrend. The current smack down is due more to strength in the US Dollar than anything else. Gold does trade as a currency sometimes and for the past few weeks it has held a strong inverse correlation to the US Dollar. I think physical demand will ultimately determine the price level, but ultimately it can be a long time when you’re trading.

TGR: Why isn’t physical demand determining the price now?

Eric Coffin: It’s because of trading in the futures market. When somebody dumps 500 tons there, gold has to drop $200 per ounce. The futures market can overwhelm the physical market in terms of volume and often does. Most traders in the futures market (NYMEX or COMEX) are not buying gold and taking delivery. They are trading as a hedge, or just trading. The physical market, the place where people actually buy bullion, coins and bars, is not predominantly in London or New York but rather in China and India. And because of the smuggling that has arisen in India to circumvent increased tariffs, and imports moving to cities that do not release import statistics in China, it is difficult to know how much bullion Asia is buying right now.

TGR: Large short-term trades in paper gold could be used to manipulate the market, and an increasing number of people believe gold is being manipulated downward in this manner. Do you agree?

Eric Coffin: I’m not really a conspiracy guy. That said, when we see things like the sale in August of 400 tons in about 10 minutes, we have to wonder what’s going on. Again, when Germany requests its gold from the US and is told delivery will take seven years, it makes you wonder how much of that gold has been hedged or lent already.

TGR: Where do you see gold going for the rest of the year?

Eric Coffin: I think we are going to be trapped in this currency trade cycle for a little while. The European Central Bank (ECB) cut its rates. One of its deposit rates is now negative. Mario Draghi, the president of the ECB, is talking about starting up quantitative easing. If that happens, or if traders believe it will, the Euro, which has already fallen from $1.40 to about $1.28 to the Dollar, could fall to $1.20 or $1.10. And this strengthening of the Dollar is not good for gold.

The other factor of gold being traded on a currency basis is the possibility of Scottish independence, fear of which has already resulted in a significant decline in the British Pound.

TGR: Will $1250 per ounce gold lead to gold miners suspending production?

Eric Coffin: If gold stays at $1200-1250 per ounce for an extended period, there will be mine closures. Obviously, not all mines have the same costs, but the average all-in cost per ounce for gold miners is about $1200 per ounce. Already, some mines are high-grading to keep profit margins up.

Most of the large miners have already cut exploration budgets pretty significantly. We can assume that the pipeline is going to get smaller and smaller when it comes to new projects, even high-quality projects.

TGR: How badly will this gold price decline hurt the junior explorers?

Eric Coffin: It’s hurt a lot of them already. It’s much more difficult to raise money than it was two or three years ago, although it’s probably slightly better now than early this year. That could change on a dime, of course, if the gold price falls to $1200 per ounce or rises back through $1300 per ounce. Already, quite a few companies are keeping the lights on but not much else. We desperately need a few good discoveries – companies going from $0.20 to $5/share and getting taken out.

TGR: You’ve been visiting mine sites in the Yukon. What do you like about this jurisdiction?

Eric Coffin: It’s a great area geologically, but it has some challenges. It can be an expensive place to work, so being close to infrastructure or designing an operation that doesn’t require a huge amount of nearby infrastructure is critical. Power costs are a big item. There’s no end of places in the Yukon where hydropower could be generated fairly cheaply, but that is not going to happen on a large scale unless the federal government steps up, and that would be nice to see.

TGR: How does Alaska compare to the Yukon as a mining jurisdiction?

Eric Coffin: They’re similar in many ways. Alaska, like the Yukon, is not low-cost, but it is mining friendly and even farther down the road when it comes to settling aboriginal issues. The key to success in Alaska is being close to the coast or major population centers or infrastructure.

TGR: How do you rate copper’s prospects?

Eric Coffin: There are several large producers that have either recently come onstream or will come onstream in the next few months. So copper is probably going to be in at least a small surplus for the next year or two. The price could fall back to $2.50-2.75/pound ($2.50-2.75/lb). I’m not terribly concerned about that. Copper should be fine in the long term and a good copper operation can make plenty of money at those prices.

TGR: The bear market in the juniors is now 3.5 years old. Should investors expect a general upturn any time soon?

Eric Coffin: I doubt it if you mean a broad market rise that lifts all boats. My expectation at the start of this year, which is looking fairly dodgy right now admittedly, was for a 30% TSX Venture Exchange gain for 2014. That is possible with only a small subset of companies doing very well, which is my expectation. Investors always want to look for the tenbaggers. It doesn’t matter what the market is like and, obviously, potential tenbaggers often turn into actual one and a half or two baggers, which is just fine. You want to find the projects with the highest potential for resource growth or new discovery and management teams that know how to explore them and finance them on the best possible terms. That is the combination that gives you the potential biggest wins.

Gold PriceComments Off on Shanghai Gold Trading: The Real Challenge to London

If China remains a one-way street for gold, it cannot become the world hub…

SHANGHAI this week launches a new international gold exchange inside the city’s free-trade zone, writes Adrian Ash at BullionVault.

Most everyone thinks this is important because “global gold traders [see] the zone as a gateway to China‘s huge gold demand.” But that’s the wrong way round. Because if it’s to have any real importance, the Shanghai FTZ gold bourse must mark a step towards China’s gold output and private holdings flowing out into the world, not the other way round.

Start with the situation today. China and the UK could hardly be more different when it comes to gold. China is the world’s No.1 gold-mining producer, the No.1 importer, and the No.1 consumer.

The UK in contrast…and despite spending its way to household debt worth 140% of income…has no gold jewellery demand to speak of. Private investment demand is also tiny compared to Asia’s big buyers

So you might think China plays a bigger role in the international gold market than does the UK. Yet nearly 300 years since it first seized the job, London remains the center of global gold flows, trading and thus pricing. For now at least.

Since 2004, and with no domestic mine output and next to no end demand, the UK has imported over 6,800 tonnes of gold, according to official trade statistics – more than China but behind India, the former No.1 buyer. It has also exported nearly 5,000 tonnes, more than any country except No.1 bar refiner, Switzerland.

That’s in a global market seeing some 4,500 tonnes of end-user demand per year. Because London is the heart of the world’s gold bullion market, and the central vaulting point for its wholesale trade. (Same applies to silver, by the way – the UK was the world’s No.1 importer and exporter in 2013.)

The relationship with prices is clear. When UK trade data (hat tip: Matthew Turner at Macquarie) show metal piling up in London’s vaults (which also offers the deepest, most liquid place for large investors to hold their gold in secure vaults, ready to sell or expand at the lowest costs) prices have tended to rise. But when the rate of accumulation in London is slowing, prices have tended to fall. Gold prices have sunk when London’s vaults have shed metal.

On BullionVault‘s analysis, those months since end-2004 where Dollar gold prices rose saw net demand for London-vaulted gold average 38 tonnes. Falling prices, in contrast, saw London’s vaults lose 16 tonnes per month on average (imports minus exports). Exclude the gold-price crash of 2013 and we get the same pattern. Average net inflows when Dollar price fell were only 15 tonnes per month between 2005 and 2012. Rising prices, in contrast, saw London vaults add 48 tonnes net on average per month.

So what’s happening with London-vaulted gold really does matter to world prices. Far more, to date, than what’s happening to China’s flows.

Why? The Middle Kingdom’s modern gold boom has come in mining, importing and refining. But in exports it just doesn’t figure. Because bullion exports are banned, thanks to Beijing deeming gold to be a “strategic metal”.

Never mind that China now boasts 8 gold refineries accredited to produce London-grade wholesale bars. Out of a world total of 74, that’s more than any other country except Japan. But Chinese-made wholesale bars never reach London (or shouldn’t…) because they are dedicated by diktat to meeting its world-beating domestic demand alone.

China’s inability to export gold bullion puts a big block on it affecting world prices. Because while metal is drawn into China when domestic prices rise above London quotes (the so-called “Shanghai gold arbitrage” trade) it cannot flow the other way when Shanghai goes to a discount. Traders can only exploit the price-gap through in one direction.

Global investment flows are further locked out by Beijing’s block on foreign cash coming into China – another key difference between the UK and China in all financial trading, not just gold. Shanghai vaults have therefore been closed to international gold investment to date. So the impact of global flows on pricing has completely passed China by.

This may change this week however, when the Shanghai Gold Exchange launches its new international gold exchange inside the city’s huge free-trade zone on Thursday. Six major Chinese banks will provide clearing and settlement services. The first 40 approved members of the exchange include London market makers HSBC, UBS and Goldman Sachs. But whether global investors will choose to hold gold in Shanghai vaults remains to be seen. China remains a Communist dictatorship, after all. Whereas London, even in the dark days of 1970s exchange controls – which barred UK investors from buying gold, as well as moving cash overseas – still freely allowed foreign money to come and go as it pleased, not least through the City’s world-leading gold and silver markets.

Remember, China’s gold market has only answered Chinese supply and demand so far. Its mine-supply leads the world…but cannot reach it. China’s demand has meantime needed imports from abroad to supplement what Chinese mines produce. That demand leapt when world prices fell in 2013, doubling China’s net imports through Hong Kong from 2012 to well over 1,000 tonnes, and clearly showing that – for now – its gold market remains a price taker, not a price maker. The running is made instead by free-flowing investment cash choosing to buy or sell down gold holdings worldwide, and that decision shows up in London, center of the world’s bullion trade.

Better yields from better mining will lead investment cash back into gold stocks…

JEFF KILLEEN has been with the CIBC Mining Research team since early 2011, covering and providing technical assessment of junior and intermediate exploration and mining companies worldwide.

Prior to joining CIBC, Killeen worked as an exploration and mine geologist in several major mining camps, including the Sudbury basin and the Kirkland Lake region. Now he has spent much of 2014 on the road vetting junior mining projects, and says – speaking here to The Gold Report – that the cash-and-catalyst mindset should remain prevalent for investors looking at explorer and developer equities…

The Gold Report: Two years ago CIBC World Markets recommended taking a short position on a selection of gold stocks. What’s CIBC’s view on gold stocks today?

Jeff Killeen: We had put out a basket of names recommending some short positions, but at that time gold was trading at about $1600/ounce ($1600 per ounce) and there was little support for the price at that level. That dynamic doesn’t seem to be at play in today’s environment. We are maintaining our current recommendation: Investors should be at market weight with respect to their gold equity allocations.

Many mining stocks have performed well in 2014 and the move has largely been motivated by several factors. First, gold bullion itself has found a footing. The gold price has traded in a range of $1250-1,350 per ounce, which is fairly narrow compared to how gold prices have moved in the past three to five years. Investors are becoming comfortable with the idea that gold will remain range bound for the coming 12 months or more, and concerns that gold could drop significantly over a short period seems to be waning with gold seeing support around $1250 per ounce.

While some profit taking on strong first half share performance is certainly justifiable, I continue to recommend buying gold stocks with a focus on companies that are currently generating healthy margins and could enjoy higher trading multiples as they gravitate up toward longer-term averages. I also like gold stocks that have underperformed relative to their peers in 2014 that are projecting improving operations or have meaningful catalysts in the near term.

TGR: What do you expect the trading range for gold to be through the end of 2015?

Jeff Killeen: Our gold price estimate for 2015 is $1300 per ounce. Next year is likely to look a lot like 2014 with typical seasonal moves and maintaining that price range of roughly $1250-1,350 per ounce for the year.

TGR: Do you think the Market Vectors Junior Gold Miners ETF (GDXJ:NYSEArca) will be up another 30% through the first eight months of 2015?

Jeff Killeen: That would be difficult. There could be stocks that realize some strong performance in the back half of this year and into next year, but I don’t think it will be as broad based as we saw early in 2014.

TGR: In the near term do you expect gold buying to gain steam or have seasonal gold buying trends become something of the past?

Jeff Killeen: We’ve spent a lot of time tracking gold’s seasonal price patterns over 5-, 10- and 15-year trends. Plotting the relative performance of gold prices over those periods shows a fairly consistent seasonal pattern. A move in the gold price in early June on the back of geopolitical tensions was unexpected and may have taken some of the steam out of a fall rally, but we need to realize that the typical fall rally is largely spurred by physical demand from the East. I don’t see a reason why typical physical demand wouldn’t materialize in 2014 and we expect the gold price to do well over the next few months.

TGR: One division of CIBC World Markets uses quantitative models to identify predictive relationships and broad market trends. What are these models telling investors about small-cap gold stocks and the gold space?

Jeff Killeen: Our quantitative analyst, Jeff Evans, has been promoting the idea that gold stocks, especially the more volatile small- to mid-cap gold stocks, have high beta outperformance relative to the S&P 500 and the Toronto Stock Exchange given the current environment for stable or marginally upward moving interest rates over the long term. That’s from a technical standpoint.

With that in mind, we have to be cognizant of the fact that we’ve seen better downside support and some strong moves in the gold price in 2014 that weren’t necessarily expected and I’m sure that has helped move some gold stocks upward. But interest rates are having an effect on how people look at gold and gold equities, and using that as a trigger to buy or sell gold stocks makes sense to me.

TGR: In June 2013 positive news had largely stopped moving equity prices. You told us then that it would be temporary. What news is moving producer and developer equities in this market?

Jeff Killeen: On the producer side, improving operations has been the biggest motivator for share prices. Although I expect a lot of the cost improvements in the gold mining space have already been incorporated into operations, the market is thinking about how sustainable those cost improvements might be. Companies that maintain lower costs through 2014, relative to where they may have been in previous years, are likely to get attention as investors think about 2015 performance and if they should consider increasing their estimates for company earnings and cash flow. Such a scenario could generate further share support for good operators. Of course, companies that realize further cost improvements in the second half of 2014 are also likely to get investors’ attention.

TGR: What about developers?

Jeff Killeen: On the developer side, we’re starting to see share prices get rewarded for good drill results, resource growth and even new discoveries. When we spoke back in mid-2013 I recommended that investors stick to the cash-and-catalyst mentality, because an exploration stock needs to have a strong balance sheet and material near-term catalysts [ie, news likely to send the stock higher]. That approach was the right one and I’d stick with that concept today.

TGR: Would you make any modifications to the cash-and-catalyst thesis given what has transpired between then and now?

Jeff Killeen: Cash and catalysts are not the only components that a company must have. The main project has to have gold grades that are amenable to the type of process it is proposing, and the economics have to work at current gold prices to have a realistic chance of seeing a takeover offer. A company definitely has to have a solid management team to navigate today’s tricky financing waters or wisely allocate capital.

TGR: Which types of companies are seeing interest from institutional investors?

Jeff Killeen: My producer coverage is in the small to intermediate market cap in the gold space. The intermediate producers tend to have a higher beta to the bullion price so that segment of my coverage seems to have sustained greater institutional interest in 2014. Despite some merger and acquisition (M&A) activity in 2014, the general feeling among investors is that although M&A is likely to continue, it’s expected to come in the form of smaller consolidations or the sale of noncore assets by majors. In that context, exploration companies are struggling to attract attention from the institutional market.

TGR: One recent drill result at TV Tower was 130.9 meters grading 1.5 g/t Au and 0.48% Cu starting at surface. You model results like these all the time. What does that look like to you?

Jeff Killeen: No project is a single drill hole, but to have a single hole with those kinds of numbers is an excellent start. If you put several intercepts like that together you can quickly build pounds and ounces. Being able to validate a surface geological interpretation is big and a great starting point for any drill program.

TGR: What’s your sense of where we are in the recovery of precious metals equities?

Jeff Killeen: I get the feeling that we have hit the bottom and taken the first leg up – but the next leg up could take some time to materialize. There are individual stocks that should have good performance through the back half of 2014 and over the next 12 to 18 months.

From a broader perspective, a lot of the cost improvements have already materialized and I think there is little producers can do to significantly improve margins or cash flow. To accomplish those things we need to see a few things happen: more fundamental support from the gold price and an increase in physical demand in India and the rest of Asia. Better yields will catalyze the generalist investor back to investing in gold stocks.

MUCH of what we think we know isn’t necessarily so, writes Tim Price on his ThePriceOfEverything blog.

The invention of the printing press with movable type ? Traditionally credited to fifteenth-century Germany and Johannes Gutenberg, it was actually invented in eleventh-century China.

Paper also originated in China long before it was used in the West. As did paper money and toilet paper (albeit today, these are pretty much interchangeable).

English agriculturalist Jethro Tull is widely credited with the discovery of the seed drill in 1701. It was in fact invented by the Chinese 2,000 years beforehand.

The first blast furnace for iron smelting is associated with Coalbrookdale – tragically close to schools in the West Midlands. It was actually introduced by the Chinese before 200 BC.

The Chinese were also first to use the fishing reel, matches, the magnetic compass, playing cards, the toothbrush and the wheelbarrow. Perhaps even golf. So how did a society apparently so dynamic and innovative by comparison with the West then enter a centuries’ long decline?

Niall Ferguson, in his excellent book Civilization (Penguin, 2012) puts forward six “identifiably novel complexes of institutions and associated ideas and behaviours” that account for the cultural and economic outperformance of the West between, say, the 16th and 20th centuries:

Competition

Science

Property rights

Medicine

The consumer society

The work ethic

Ferguson defines these trends as follows:

Competition: “a decentralization of both political and economic life, which created the launch-pad for both nation-states and capitalism”.

Science: “a way of studying, understanding and ultimately changing the natural world, which gave the West (among other things) a major military advantage over the Rest”.

Property rights: “the rule of law as a means of protecting private owners and 3. Property rights: “the rule of law as a means of protecting private owners and peacefully resolving disputes between them, which formed the basis for the most stable form of representative government”.

Medicine: “a branch of science that allowed a major improvement in health and life expectancy, beginning in Western societies, but also in their colonies”.

The consumer society: “a mode of material living in which the production and purchase of clothing and other consumer goods play a central economic role, and without which the Industrial Revolution would have been unsustainable”.

The work ethic: “a moral framework and mode of activity derivable from (among other sources) Protestant Christianity, which provides the glue for the dynamic and potentially unstable society created by “killer apps” 1 to 5″.

For our purposes we are most interested in Ferguson’s first “killer app”, Competition. But we will also refer to it in a slightly different context – “the lack of bureaucracy”.

As Fergsuon’s chart shows, from 1000 AD to its high water mark in the 1960s, UK GDP relative to China’s was a one-way bet. Since then, however, the trend has gone into reverse.

What can account for this dramatic reversal of economic fortunes? Economic reforms in China, led by Deng Xiaoping in the late 1970s, are likely to be responsible for at least part of the turnaround. But the relentless and sclerotic expansion of the State in Britain has also played a role.

At the turn of the last century, UK state spending accounted for roughly 10% of the economy and the private sector accounted for the rest. But as the welfare state has swelled, government spending has mushroomed to account, now, for something like half or more of the entire economy. And state spending, by and large, is inefficient spending – at least by comparison with the inevitably more disciplined for-profit sector. In other words, our relative economic prospects have declined in inverse proportion to the expansion (metastasis) of the State.

In turn, bureaucratic parasitism likely accounts for productivity differentials in the Eurozone; the German State accounts for roughly 45% of its economy, the French State 56%.

Politicians have been able to swell the State thus far only with assistance by two groups: with the involuntary support of taxpayers, and with the connivance of central bankers. Popular resentment of what is laughably termed ‘austerity’ threatens the ongoing indulgence of the first group; the almost terminal straining of market forces by the latter runs the risk of a disorderly collapse of confidence in bond markets, after which continued Western deficit spending would be virtually impossible.

We seem to be close to the endgame. Even as perversely, record-low bond yields (indiscriminately across markets as diverse as Austria, Belgium, Germany, Holland, Finland, Ireland, Italy and Spain) have sent desperate investors scurrying into stocks instead, those same investors are, with extra perversity, displaying a similar lack of discrimination and not even attempting to locate relative value within markets.

Extraordinarily, the Wall Street Journal points out that:

“Investors are pouring money into Vanguard Group, the epitome of the hands-off approach to investing, flocking to funds that track market indexes and aren’t run by stock pickers or star managers. The inflow has pushed the mutual-fund giant to almost $3 trillion in assets under management for the first time. The surge is part of a sea change in the fund business in which investors are increasingly opting for products that track the market rather than relying on managers to pick winners…

“Investors poured a net $336 billion into passively managed stock and bond funds in 2013, handily beating the $53 billion invested in traditional mutual funds of the same type, according to Morningstar. So far this year through July, investors put a net $177 billion into those passive funds, compared with $74 billion in actively managed funds…Through July, passively managed stock funds have seen a net $128.4 billion in investor inflows, compared with $18 billion for traditional stock funds…”

Nor is this lack of judicious investment a product of bullish US market sentiment. The same arbitrary index-following – at all-time highs – is being pursued in the UK. Trade magazine FTAdviser reports that “Retail investors put more money into tracker funds in July than in any other month since records began, according to the latest IMA data.”

Index-tracking may have merit at the bottom of the market, but at the top?

Having singularly failed to reform or restructure their dilapidated economies, many governments throughout the West have left it to their central banks to keep a now exhausted credit bubble to inflate further. Unprecedented monetary stimulus and the suppression of interest rates have now boxed both central bankers and many investors into a corner. Bond markets now have no value but could yet get even more delusional in terms of price and yield. Stock markets are looking increasingly irrational relative to the health of their underlying economies. The Eurozone looks set to re-enter recession and now expects the ECB to unveil outright quantitative easing.

If the West wishes to regain its economic vigour versus Asia, it would do well to remember what made it so culturally and economically exceptional in the first place.

MARCUS GRUBB is the managing director of investment strategy for market-development organization the World Gold Council.

Based in London, he leads both investment research and product innovation, as well as marketing efforts surrounding gold’s role as an asset class. Grubb has more than 20 years’ experience in global banking, including expertise in stocks, swaps and derivatives.

Here, and after the release of the World Gold Council’s latest quarterly Gold Demand Trends survey, Marcus Grubb speaks to HardAssetsInvestor‘s managing editor Sumit Roy about some of the report’s more surprising conclusions…

HardAssetsInvestor: Physical investments demand fell 56% in the second quarter from Q2 2013, but it’s still at a pretty high level historically. Do you think it’s going to rebound, stabilize or fall further from here?

Marcus Grubb: Gold bar and coin demand is substantial in the United States, but even bigger in Asia. The big falls were in a lot of those Asian countries. But we should put this in context. Last year in Q2 there was that big decline in the gold price to the tune of more than 20%. That triggered a big consumer-buying binge in Asia. We had great figures last year and so this year’s drop of 56% is from those high levels.

Looking forward, things are likely to get better – first of all, that comparisons get easier year in Q3 and Q4. That’s because Q2 was really where all the big events happened – the price drop, the huge redemptions in the ETFs, the big consumer demand response with the big jump in jewelry and bar and coin demand. So Q3 and Q4 are just mathematically going to look better.

The other thing is that you could say some of the softness in this latest quarter was due to the fact that the price trend has been ambiguous this year. Gold’s done better than many expected, and has returned quite well, better than some stock markets around the world. But it’s too early to really say there’s a strongly rising price trend for gold. And I think a lot of the bar and coin consumers in Asia are looking for that. There’s evidence they have held back on buying until there’s a clearer direction for the gold price.

The final thing I’d say is that the figure for total investment for Q2 is actually up 4% compared with last year. And that’s really because the performance of the ETFs are so much better than they were in Q2 2013. They still saw redemption of about 40 tonnes, but there were redemptions of 402 tonnes in the same quarter last year. ETF investors are definitely more comfortable owning gold this year than they were last year.

HardAssetsInvestor: And those ETF investors, would you say they’re predominantly Western investors?

Marcus Grubb: Yes. The majority of the holdings in the ETFs are really in six to eight different instruments, either in the United States or UK or Europe.

The other thing is that the investors who were in gold ETFs for the price appreciation and for the financial system hedge after the Lehman failure in ’08 are the people who have left gold. They’ve reallocated into other asset classes. A lot of those investors will say, “We bought gold; we had it because we were worried about the Dollar and about the financial system. When things started to improve last year, we moved out of our gold position and we sold at a profit.” They often will say “gold did the job we wanted it to do.”

The people who are still left now – and remember there’s 1,850 tonnes globally still in gold ETFs – those investors are using gold as a hedge asset, as an insurance policy, as a hedge against inflation if it comes, a hedge against tail risks, and as a diversifier. So we see them as pretty strong holders of gold in small allocations in their portfolios.

HardAssetsInvestor: Are the remaining ETF investors basically going to be keying off Federal Reserve monetary policy and things like that?

Marcus Grubb: That’s certainly one key element. But also, central bank policy globally and interest rate policy globally. And that’s part of the reason things are actually better on the ETF front this year than they were last year.

If you look at the rest of the world, we’ve just seen pretty awful GDP number in Japan. A lot of that was due to the consumer tax increase in that country, but it’s still a big negative number. And then you see the most recent numbers in Europe, Germany and Italy showing that the Eurozone is also swerving down. It looks like the ECB is almost definitely going to ease policy further. Whichever tool they choose – whether it’s interest rates or even quantitative easing – most strategists and economists are betting on further monetary easing in Europe between now and the end of the year.

HardAssetsInvestor: And we did see the German 10-year bond yield fall below 1% recently. Is that bullish for gold, at least from an European perspective?

Marcus Grubb: Yes. And I think that’s why if you look at the latest ETF numbers globally in July and August, we’ve had net new creates. I think those two things are related.

HardAssetsInvestor: Looking at individual countries you mentioned earlier, how is demand from China and India faring so far this year after last year’s record year?

Marcus Grubb: If you look at the half-year, total demand in China is about 471 tonnes. That’s still a fall compared with the first half of 2013 to the tune of about 35%. And India is at 394 tonnes for the half-year, down about 33%.

Having said that, we have been in the weaker seasonal period for gold demand. We should now see stronger numbers in both Q3 and Q4. You’ve got the ending of the monsoon in India and then Diwali. And then you’ve got the same phenomenon in China. There are some festivals in China in the autumn, and then the run-up to the Chinese new year where you see increase in gold imports in that country.

We actually think by year-end you’re going to see China come in around 900 to 1000 tonnes for the full year. And we think India will come in around 850 to 950 tonnes. If that happens, that’ll still be the second-best year for China ever, and not a bad year for India either.

HardAssetsInvestor: It looks like central banks continued to accumulate gold steadily in Q2. But is Russia pretty much the predominant buyer when it comes to central banks?

Marcus Grubb: I would certainly say this year they have been. It’s also true to say that over the last decade, Russia is the largest central bank buyer of gold that we know about. The Russian central bank now has over 1,000 tonnes of gold. They’re holding just under 10% of reserve assets in physical gold.

But overall, central banks were strong, and in fact, we just revised our target for these figures for the year. We now expect central bank purchases around 500 tonnes for this year. If we get that, it will be the second-best year since the 1960s.

These central banks continue to buy gold as a currency diversifier because they’re very overweight US Dollars. Gold acts as a diversifier against sovereign debt and partly against equities too, because a number of central banks are now buying equities, which is a recent phenomenon. As you know, gold is a good hedge against equities.

HardAssetsInvestor: Any word on China’s central bank purchases?

Marcus Grubb: No, and they are not contained in these figures. We have no new information on that. Officially, Chinese gold holdings are around 1,054 tonnes. The last disclosure they gave was in 2009.

HardAssetsInvestor: Presumably those could be pretty big purchases going on behind the scenes, could they not?

Marcus Grubb: It’s hard to comment without any official releases or disclosure. But it is interesting to note that if you look at the Chinese gold market for the last seven years or so, there is a surplus in the demand and supply figures. In other words, more gold has gone into China through imports than you can account for through local demand from jewelry, bars and coins, technology, and other measured sources of demand from the private sector. Over the last several years, the total is that somewhere between 800 and 1,000 tonnes of supply has gone in and can’t be accounted for.

Now, some of that may have gone into inventories as the gold industry’s gotten a lot bigger in China over the last seven years because of the boom in the market. There are a lot more jewelry outlets, a lot more fabrication factories for jewelry, etc. In any case, some of that gold is sitting in holdings somewhere in China, and it’s not measured in the consumer demand. So people can draw their own conclusions.

HardAssetsInvestor: Turning to the supply side, we saw mine production up 4% from a year ago in the latest quarter. Is that significant?

Marcus Grubb: It’s likely we will see a slowdown in the rate of growth of mine production later this year. This latest increase is effectively a hangover from the expansion we saw before last year’s price decline. This may be the year for peak mine production in the medium term.

It’s quite likely that sometime between now and the early part of 2015, gold mine production will peak, and after that, it will decline as a result of all the measures that have been taken in the last 12-18 months in response to low gold prices.

You’re seeing large amounts of cost cutting, delays and postponements to projects, some closures and some very large projects in the hundreds of millions or even billions being put on ice until the market improves and more funding is available. That takes time to kick in and affect supply, but we think it will start to do that later this year, and definitely into 2015.

Although the price isn’t affected directly by that in the short term, it reaffirms that, in the long run, gold is in limited supply against strong demand. The other key factor, which is much more price sensitive, is recycling. Year-to-date, recycled gold supply is actually down for the half-year by around 8%. The only way you can increase the supply from recycling is by having a significant increase in the gold price.

All of this says gold is returning to its longer-term position of being in a shortage or a deficit, where the demand from central banks, technology, jewelry and the consumer will push this market back in a deficit soon. If investors come back into the market, the deficit will be just that much larger.

HardAssetsInvestor: I want to get your take on the producer hedging that we saw last quarter. How does producer hedging impact supply?

Marcus Grubb: We did have the first hedge for some, which has tipped this quarter into net hedging of 50 tonnes, versus Q1 where we had a de-hedge. But it’s fair to say that this latest hedge is very mining project-specific. We don’t see this as marking a return to hedging generally.

Moreover, the hedge book is still near an all-time low, with about 125 tonnes in total. Also, this hedging is not necessarily the same as the hedging we had in the bear market in gold either. That entailed borrowing gold from central banks, selling it at spot with the banks in the middle providing the financing, and then the mining company producing into the hedge to deliver gold back to the commercial bank. And then from them, back to the central bank.

My sense of these hedges is that they are more collateralized financings, where effectively the mining company is selling forward production at a fixed price to raise capital for developing the mine. In that sense, I would say it doesn’t have necessarily the same impact on supply that the old style of hedging did, where the gold was borrowed and sold in the spot market.

HardAssetsInvestor: That’s an interesting point. So it’s not really adding to physical supply, unlike in the past.

Marcus Grubb: I would say that it potentially isn’t, no. Without knowing more details about that particular transaction, I would say it won’t have as much effect on physical supply as the hedging did in the past.

GOLD PRICES reached a weekly gain of 2.2% at $1322.55 per ounce Friday morning in London, amid a drop in European and American stock markets and renewed violence in Ukraine and the Middle East.

The US President authorised limited air strikes against Islamic State (formerly ISIS).

Rocket fire from Gaza across the border resumed after a 72-hour ceasefire, so did Israeli air strikes.

Meantime, the Euro versus Dollar briefly touched $1.3400 Friday morning before falling back under this 9-month low last broken at the end of July.

Geopolitical headlines took the fore and not economic data. “Yesterday, a Ukrainian fighter jet was shot down by rebel forces and this started the rally in gold,” writes David Govett at London metals brokerage Marex Spectron. Then, President Obama authorised military strikes in Iraq and this morning the truce in Gaza ended.

“All in all, pretty much a perfect storm for gold prices.”

Gold prices in USD were set to approach the weekend at a three-week high ending a long run of weekly losses.

“Ongoing geopolitical events in Russia/Ukraine and the Israel/Palestine conflict [gave] support to the precious complex,” says the Swiss precious metals refinery group MKS in a note, adding that traders moved out of falling equities into safe haven assets providing gold with a gain of 9.2% in 2014 so far.

Panic in the equity markets, potential US strikes and the Ukraine crisis offered a safe haven-demand for gold, comments Wing Fung Precious Metals in Hong Kong, adding that “gold could climb quickly up to $1325 per ounce.”

However, seeing enhanced volatility short term, Govett believes that when “situations calm down or resolve themselves, the price will come straight back down again.”

Silver lagged behind gold but crept back up and broke the $20 mark Friday morning, a level it kept from June 19 until last Wednesday, after touching seven-week lows earlier this week. Silver prices were on track for a loss of around 1% on the week so far.

The Bank of England kept interest rates at their 5-year record low of 0.5% on Thursday. Going into the weekend gold prices for UK investors were set to gain 1.7% and reach the highs of mid-April, at around £782.55 per ounce.

Another central bank declaration of note: ECB president Mario Draghi confirmed yesterday the European quantitative easing was in preparation.

Gold prices in Shanghai meantime maintained a premium of $1-2 over and above London prices this week amid falling Asian stocks and China’s trade surplus record high.

The physical gold holdings of the giant gold ETF, the SPDR Gold Trust (NYSEArca: GLD), shed more than 2 tonnes Thursday but remained unchanged Friday for a total of 797.654 tonnes.

Gold PriceComments Off on Gold Prices Flat Again But Shanghai Premium "Healthy" as London Gold Borrowing Rates Rise

GOLD PRICES held in a tight range again Tuesday morning in London, trading less than 0.2% down from last week’s finish as crude oil ticked higher with major government bond interest rates.

European stock markets continued their rally from last week’s 4.5% drop, but Asian equities were muted after new data showed China’s services sector flat-lining in July.

Sinking from June’s 15-month high, the Markit consultancy’s non-manufacturing PMI of 50.0 was the lowest reading since the series began in 2005.

Gold prices in Shanghai closed Tuesday slightly lower in the Yuan, but extended their $2 per ounce premium above London quotes of $1291.

“The premium in Shanghai,” Bloomberg quotes analyst Nikos Kavalis at London-based consultancy Metals Focus, “might be a sign that the inventory overhang in China we saw earlier this year is not a big issue.”

“We expect a very healthy rebound in physical demand in the last four months of the year.”

Suggesting tighter supply in London – heart of the world’s wholesale trade – the cost of borrowing gold in one-month deals today held near the highest levels since May, with gold lenders asking for a rate of interest on top of the cash interest they earn during such gold-for-money swaps.

This rare situation, as shown on data collected from the market-making members of the London Bullion Market Association, applied throughout summer 2013’s sharp gold rally from 3-year lows, and again as prices rose this spring.

The US Mint has sold 56% fewer American Eagle gold coins so far in 2014 than the same period last year.

Yesterday saw the gold bullion needed to back shares in the SPDR Gold Trust (NYSEArca:GLD) drop by 1.8 tonnes, taking the world’s largest exchange-traded gold fund’s holdings back to 800 tonnes – a five-year low when first reached last December.

“While the present negative factors remain,” says a note from Germany’s Commerzbank – “a strong US Dollar, weak physical demand in Asia, and weak coin sales in the West – we do not envisage any serious price gains” in gold.

THERE IS a war being conducted out there in the financial markets, writes Tim Price on his ThePriceOfEverything blog – a war between debtors and creditors, between governments and taxpayers, between banks and depositors, between the errors of the past and the hopes of the future.

How can investors end up on the winning side ? History would seem to have the answers.

For history, read in particular James O’Shaughnessy’s magisterial study of market data, What Works on Wall Street (hat-tip to Abbington Investment Group’s Peter Van Dessel).

The chart below shows the results accruing to various strategies across the All Stocks universe -all companies in the Standard & Poor’s Compustat database with market capitalisations above $150 million, a dataset which comprises between 4,000 and 5,000 individual companies. The analysis takes in over half a century’s worth of data.

Making the (fairly reasonable) assumption that the data in this study is sufficiently broad to mitigate the effects of shorter term market “noise”, the results are unequivocal. Buying stocks with high price-to-sales (PSR) ratios; buying stocks with high price / cashflow ratios; buying stocks with high price / book ratios; buying stocks with high price / earnings (PE) ratios; all of these are disastrous strategies relative to the performance of the broad index itself.

Caution: these all happen to be ‘growth’ strategies.

But the converse is also true – in spades. Buying stocks with low price-to-sales ratios; buying stocks with low price / book ratios; these are both outstandingly successful strategies over the longer term, converting that initial $10,000 into over $22 million in each case. Buying stocks on low price / cashflow ratios is also a winning strategy. The relatively simple ‘high yield’ and ‘low p/e’ strategies also comfortably outperform the broad market. Note that these are all ‘value’ strategies.

This leads O’Shaughnessy to question the legitimacy of the so-called Capital Asset Pricing Model, in which investors are compensated for taking more risk:

“The higher risk of the high P/Es, price-to-book, price-to-cashflow, and PSRs went uncompensated. Indeed, each of the strategies significantly underperformed the All Stocks Universe.”

Perhaps the market is indeed less efficient than certain academics would have us believe. The world’s most successful investor, Warren Buffett, would seem to think so. As he was quoted in a 1995 issue of Fortune magazine,

“I’d be a bum on the street with a tin cup if the markets were always efficient.”

And note that careful addition of the word “always”. Buffett wasn’t even going so far as to suggest that the markets are never efficient, but rather that the patient investor can take advantage of Mr. Market’s occasional lapses into the realms of absurdity, whether in the form of bullishness or outright despair.

O’Shaughnessy frames the returns from these various ‘growth’ and ‘value’ strategies more explicitly in the chart below.

Special pleaders on the part of ‘growth at any cost’ might argue that the time series is insufficient. But if 52 recent years – easily an investor’s lifetime – taking in at least two grinding bear markets are not enough, how much would be ?

Again, the conclusions are clear. Buying stocks on low price-to-sales ratios is a winner, tying with stocks on a low price-to-book ratio with an annualised return over the longer term of 15.95%.

Low price-to-cashflow is also a stellar performer. Buying stocks with a high yield also beats the broad market, as does buying stocks with low price / earnings ratios. Again, these are all explicit ‘value’ strategies.

Since we appear to be living through something of a speculative bubble (a bubble inflated quite deliberately by explicit central bank action), it is worth recalling one prior instance of ‘growth’ outperforming. As O’Shaughnessy points out,

“Between January 1, 1997 and March 31, 2000, the 50 stocks from the All Stocks universe with the highest P/E ratios compounded at 46.69% per year, turning $10,000 into $34,735 in three years and three months. Other speculative names did equally as well, with the 50 stocks from All Stocks with the highest price-to-book ratios growing a $10,000 investment into $33,248, a compound return of 44.72%.

“All the highest valuation stocks trounced All Stocks over that brief period, leaving those focusing on the shorter term to think that maybe it really was different this time. But anyone familiar with past market bubbles knows that ultimately, the laws of economics reassert their grip on market activity. Investors back in 2000 would have done well to remember Horace’s Ars Poetica, in which he states: ‘Many shall be restored that are now fallen, and many shall fall that are now in honour.’

“For fall they did, and they fell hard. A near-sighted investor entering the market at its peak in March of 2000 would face true devastation. A $10,000 investment in the 50 stocks with the highest price-to-sales ratios from the All Stocks universe would have been worth a mere $526 at the end of March 2003.

“You must always consider risk before investing in strategies that buy stocks significantly different from the market. Remember that high risk does not always mean high reward. All the higher-risk strategies are eventually dashed on the rocks.”

This might seem to imply that there is safety simply in the avoidance of explicitly high-risk strategies, but we would go further.

We would argue today that central bank bubble-blowing has made the entire market high-risk, with a broad consensus that with interest rates at 300-year lows and bonds hysterically overpriced and facing the prospect of interest rate rises to boot, stocks are now “the only game in town”. We concede that by a process of logic and elimination, selective stocks look way more attractive than most other traditional assets, but the emphasis has to be on that word “selective”. We see almost no attraction in stock markets per se, and we are interested solely in what might be called ‘special situations’ (notably, in ‘value’ and ‘deep value’ strategies) wherever they can be identified throughout the world.

We also note, in passing, that markets such as those of the US appear to be virtually bereft of such ‘value’ opportunities, whereas those in Asia and Japan seem to offer them in relative abundance. In this financial war, we would prefer to be on the side of the victors. If history is any guide, the identity of the losers seems to be self-evident.

India’s Gems & Jewellery Export Promotion Council said gold bar imports to the world’s former No.1 consumer nation doubled last month from the same month in 2013.

But in what Reuters calls “a seasonally slack period”, improved supplies have seen Indian premiums over London gold prices halve this week, falling as low as $5 per ounce vs. late 2013’s record level of $160 when the current import curbs first hit.

“It will be political events that provide the market with some potential direction,” says a Singapore dealing note after warning yesterday morning that gold and silver “look[ed vulnerable to a correction lower.”

The Gaza death-toll from the last fortnight’s conflict with Israel was today put above 800.

Moscow’s stock market meantime fell hard as Dutch and Australian police reached the crash site of Malaysian flight MH17 in eastern Ukraine, dropping 2.1% for the week – but holding well above this spring’s 4-year lows – after the Russian central bank surprised FX traders with a half-point hike on interest rates.

Now at 8.0%, Russia’s key overnight rate is only just ahead of Russia’s latest inflation reading.

The Ruble rallied against the Dollar, but the British Pound fell to 1-month lows as UK GDP data met analyst forecasts for 3.1% annual growth.

That buoyed the gold price in Sterling at £762 per ounce, down 0.7% on the week.

“Gold plunged Thursday,” says London market maker Scotia Mocatta’s New York desk in its daily note, “falling below both the 100-day and 50-day moving averages.”

What Scotia’s analysts call “bearish trend and momentum indicators” are now “providing for ample room to the downside.”

“The current correction should fetch 1285/81, mid-June highs,” says technical analysis from Societe Generale, after the metal “failed to establish itself” at late-June’s return to April’s high of $1331.

Gold prices, the SocGen note concludes, will now need “a break above [July’s] steep resistance line” coming down from the peak at $1345 and now sitting at $1300 “to prompt positive signals.”